The Noble Purpose of A Credit Score
To many a credit score may seem like an obnoxious or necessary evil but before it became such a complex entity its purpose was actually quite noble. The purpose of credit scores is to accomplish all of the following –
• Detect fraud in credit or insurance applications
• Calculate the amount of profit a credit card issuer is likely to make on an account by helping calculating an interest rate on the amount of the loan
• Predict the risk of default on a loan or bankruptcy by looking at your comments and the three digit number that represents your score
• Forecast the probability for an insurance company that a policyholder will cost an insurer money as it is has been proved in studies that people with more debt are also most likely to make an insurance claim
• Determine the risk that a consumer will default on a certain type of account such as a utility bill, auto loan, mortgage or cell phone account
• Forecast to a lender, creditor or collection agency just how much a borrower is likely to be able to pay on a delinquent account
• Anticipate if an individual is likely to pay the balance on a credit card down to zero or if they will always maintain a balance that high interest rates can be charged for
• Predict the likelihood of whether or not someone is likely to respond to a direct mail solicitation for credit cards, respond to an email inquiry or respond to telemarketing calls.
It is also important to note he vast majority of all credit scores are developed by the same company that created FICO: Fair Isaac. That is why in this guide when we refer to your credit score it means a score based on the Fair Isaac system. FICO is just the acronym for Fair Isaac Credit Organization so as it is mentioned repeatedly through this guide don’t let the term confuse you.
FICO is the industry leader when it comes to calculating credit scores and it is used by all three of the major credit bureaus to create a three-digit description of your financial security and future. Other formula designs may differ from the FICO calculations in small ways but are mostly modeled on the structure of a FICO assessment. A good example of a credit score based on FICO is the NextGen score, which is a newer, report that is a cousin of the Fair Isaacs report.
Although, as you will find out in the next section, there are hundreds of credit scoring companies, you are mainly affected by FICO which is used to determine the outcome of billions of lending decisions a year including 75% of mortgage lending assessments.